Can the Stock Market Capitalize R&D Expenditures?*

Paul Zarowin

NYU

Can the Stock Market Capitalize R&D Expenditures?*

(*when firms aren’t mandated to)

We examine the UK stock market’s valuation of firms’ R&D expenditures around the time of the switch from UK GAAP to IFRS in 2005. Under both regimes, research expenditures and development expenditures that did not meet capitalization conditions must be expensed. Under UK GAAP, firms had the option to expense or capitalize development expenditures that met capitalization conditions. Mandatory expensers did not have capitalizable R&D expenditures. Voluntary expensers had such expenditures, but chose to expense them. The distinction is important, because capitalizable R&D expenditures have a higher market valuation than ineligible expenditures. Under IFRS, capitalizable expenditures must be capitalized, so voluntary expensers were required to reveal their type. We find that under UK GAAP, the UK stock market valued the R&D expenditures of both expensers equally; R&D of voluntary expensers was valued more highly only under IFRS. Thus, without mandatory capitalization, the market could not properly value firms’ R&D expenditures.